Life Insurance: A guide to definitions, terms, and policy types

What is life insurance?

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A life insurance policy is a contract between you and an insurance company. The basic terms tend to be simple: You make payments to the life insurance company; in return, they promise to pay your family a sum of money if you die.

But not everyone has basic needs. What if you need protection that lasts your entire life? What if you don't want the entire payout to go to your family? What if you need a wealth-building asset? Different types of policies fulfill the promise of life insurance in different ways. To help you better understand the choices - without overwhelming you with details - we'll start by defining a few key features of a life insurance policy, then tell you how different types of policies work and why people get them.

Important life insurance terms and definitions

Death benefit 

The amount of money the life insurance company pays out if the insured person dies. It's almost always paid as an income tax-free lump sum.

Beneficiaries

The person or people who get the death benefit. It can all go to a single person (e.g., a surviving spouse), or it can be divided by percentage among a few people (e.g., a spouse could get 50%, and two adult children could each get 25%). Notably, a beneficiary doesn't have to be a blood relative or even a person – if you choose, you can leave all or part of your death benefit to an entity, such as a charitable cause.

Policy term

The time period that the policy is in effect, during which the insurer is obligated to pay a death benefit. In a term life insurance policy, it's defined as a specific number of years, typically no more than 30. In a permanent policy, the term lasts indefinitely - for as long as the insured person is alive and premiums are paid.

Premium 

The amount you pay the life insurance company each month, quarter, or year to keep the insurance coverage in effect.

Cash value 

A wealth-building component of certain policies: A portion of the premiums paid are set aside as cash value that grows tax-deferred over time.1 You can borrow against the cash value, use it to pay premiums, even cash it out to help supplement retirement income.2   A permanent insurance policy can have cash value; a term policy does not.

The different types of life insurance policies and how they work

Term life insurance

A term life policy covers the policy owner for a specific term or length of time, typically between 10 and 30 years. It is sometimes called "pure life insurance" because, unlike permanent insurance, there's no cash value component – it's designed solely to give your beneficiaries a payout if you die during the set period of the term. Most term life policies have level premiums, so you pay the same amount every month. A term policy is also typically less expensive than a permanent policy with the same amount of insurance protection. However, when the term expires, that protection is gone – you either have to go without or get a new policy, which will likely be more expensive because you are older. However, many providers – including Guardian – let you convert a term policy to permanent life insurance for part or all of the coverage period. 

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Whole life insurance

A whole life policy is the simplest form of permanent life insurance, providing coverage that lasts your entire life. Like other permanent policies, it includes cash value that grows over time on a tax-deferred basis, so you don't pay taxes on the gains.3 Compared to other forms of permanent life, a whole life policy provides the most guarantees:4

  • The premium payment remains the same for life
  • The death benefit amount is guaranteed
  • The cash value grows at a guaranteed rate of interest

Cash value can provide a number of important benefits you can use while you're still alive. For example, you can take out personal loans against it (however, any outstanding loans may be deducted from the death benefit). You can use policy cash value to help pay your premiums and keep your coverage in later years. Or you can even use the policy's cash surrender value for funds to supplement income in retirement. And when you get a whole life policy from a mutual company, such as Guardian, your policy can also earn annual dividends. While not guaranteed, Guardian has paid a dividend every year for over 150 years.

Universal life insurance

A universal life policy is another form of permanent insurance that offers lifetime coverage and the benefits of cash value. But there's a key difference compared to whole life: the premiums can change.5 This gives added flexibility to people with income that varies.

With a universal policy, you can raise or lower your premium payments within the policy's limits.6 However, paying in less could result in the need to pay higher premiums in later years to keep your coverage. Even so, this type of policy can adjust to life circumstances while providing cash value growth. Having another child, moving on to a different job, or taking out a loan to buy a business — all might be instances where this combination of protection and flexibility is needed.

Final expense insurance

Final expense insurance is a form of life insurance intended only to cover end-of-life "final expenses" such as funeral and burial costs. The coverage is permanent, in the sense that if you keep paying premiums, the policy will remain in effect. Final expense coverage is often bought by older people without dependent children because it helps the insured person protect loved ones who might otherwise have to cover these costs. While the premiums for these plans tend to be modest, the death benefit is also minimal –  it's not meant to provide ongoing financial support to a beneficiary. Younger, healthier people will typically find greater value in a whole life, universal, or term life policy.

Simplified issue and guaranteed issue insurance

Most life insurance policies are underwritten and require a medical exam as part of the application process so that the provider can assess your risk to insure. However, simplified issue and guaranteed issue policies don't require a medical exam. These policies are primarily designed for older applicants or those with serious health problems who may not qualify for policies that require a medical exam. 

Some term policies and most final expense policies are either simplified issue or guaranteed issue. When applying for a simplified issue policy, you'll be asked to fill out a health questionnaire in place of an exam. With a guaranteed Issue policy, you won't be asked to undergo an exam or complete a questionnaire – no medical information is needed to qualify for approval. However, these policies typically offer lower coverage levels than other types, and premiums tend to be higher because the insurance company has to assume that there's a high risk to providing coverage.

Group life coverage

This is life insurance that you buy as part of a group – typically through work as part of your employee benefits package or via a member organization. Most group life plans offer term life, but some companies also offer permanent coverage as a voluntary (employee-paid) benefit. 

Until recently, individual policies – bought through agents or directly from insurance companies – were the most common way to get life insurance. Now, more Americans are covered by employment-based group policies. These plans offer relatively affordable premiums because the company or organization is effectively "buying in bulk." Some employers even provide workers with term coverage equal to 1x their salary at no cost to the employee. Group policies may also be simplified issue, at least for lower coverage amounts, which helps employees with health issues obtain coverage. On the other hand, coverage amounts are usually limited. 

Group life may not provide the comprehensive coverage you want, but it can be an easy, affordable way to start or supplement your life insurance protection. If available, find out if the policy is portable: that means that if you leave your job, you can take your coverage with you.

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One more term you should know: Financial Strength Ratings

No matter what kind of policy you get, you probably want to get it from an experienced insurer with a long record of paying their claims. There are independent organizations that assess the financial soundness of life insurance companies and assign them Financial Strength Ratings, or FSRs.7 They are an objective way to help determine if the company that guarantees payment of your claim will be there many years down the road. Consider insurers with high ratings across all of the rating agencies.

Taking the next step

If you're looking to purchase life insurance, consider talking things over with someone who can help you decide whether term life, whole life, or another type of coverage is right for you. The answer will depend on your age, financial situation, family status, and other factors such as life expectancy and plans for the future. A broker or financial professional can help you compare alternative options, determine which type of policy is best for you, and explain how it can be tailored to your needs. If you don't have someone to discuss insurance with, Guardian can help you find a nearby financial representative who will listen to your needs and help guide you to a solution.

Frequently asked questions about types of life insurance

What is life insurance, and what is its purpose?

A life insurance policy is a contract between an individual and an insurance company. The policyholder makes payments to the insurer; in return, they promise that person's beneficiaries a sum of money if the insured person dies. The primary purpose of a policy is usually to provide income replacement and financial protection for loved ones, helping them cover living expenses, maintain mortgage payments, and the like if the insured dies and can't support them.

What is permanent life insurance?

Permanent life insurance is life insurance that covers you for your entire life rather than a limited period, as with term life insurance. Whole life insurance and universal life insurance are two types of permanent life insurance that can cover you indefinitely while accumulating cash value.

What is cash value life insurance?

This is any permanent life insurance policy with a cash value that can be accessed during your lifetime. Whole life and universal life are the two most common types of life insurance with cash value.

What is group life insurance?

This is a life insurance policy you buy at a group rate, usually through your employer. If your employer doesn't offer life insurance, you can buy an individual life insurance policy.

What is accidental death insurance?

This type of life insurance provides financial protection in the case of a fatal accident, such as a car crash. However, the coverage amount is not paid out if the policyholder's death results from terminal illness or disease. According to the Insurance Information Institute, only 6.1% of deaths in 2019 were caused by accidents ("unintentional injury"); all other deaths would not be covered by an accidental death policy.

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Disclaimer

1 Some whole life polices do not have cash values in the first two years of the policy and don’t pay a dividend until the policy’s third year. Talk to your financial representative and refer to your individual whole life policy illustration for more information.

2 Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses, or is surrendered, any outstanding loans considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under 59 ½, any taxable withdrawal may also be subject to a 10% federal tax penalty.

3 Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation.

4 All whole life insurance policy guarantees are subject to the timely payment of all required premiums and the claims paying ability of the issuing insurance company. Policy loans and withdrawals affect the guarantees by reducing the policy’s death benefit and cash values.

5 Permanent life insurance consists of two types: whole life and universal life. Cash value grows in a participating whole life policy through dividends, which are declared annually by the company's board of directors and are not guaranteed. Cash value grows in a universal life policy through credited interest and decreased insurance costs. The cash value of both policy types benefits when the policyholder pays an amount above the required premium.

6 Universal Life Insurance may lapse prematurely due to inadequate funding (low or no premium), increase in cost of insurance rates as the insured grows older, and a low interest crediting rate. This does not apply to universal life policies which have a secondary guarantee, but if the secondary guarantee requirements are not met the policy will most likely lapse.

7 Financial information concerning Guardian as of December 31, 2020, on a statutory basis: Admitted Assets= $68.1 Billion; Liabilities = $60.3 Billion (including $48.9 Billion of Reserves); and Surplus = $7.8 Billion

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